Do Local Investors Always Know Better? Evidence from China's Market Segmentation

It is well documented that domestic investors have an information advantage over foreign investors. We utilize the market segmentation of Chinese A- and B-shares to disentangle the information sets of domestic versus foreign investors. We find that while domestic investors lead foreign investors in firm-specific information, the latter are better at incorporating macro-level information into stock prices. Thus, our results indicate that, in contrast to conventional beliefs, foreign investors are not at an absolute information disadvantage in emerging markets. In addition, we find that domestic investors' firm-specific information advantage is weakened among firms that have higher accounting quality and in situations where foreign investors face fewer cultural and communication barriers. Taken together, our paper indicates the key information role played by foreign investors and the importance of financial reporting quality in emerging markets.